Germany and France Reach Greece Deal, but Problems Remain

Germany and France Reach Greece Deal, but Problems Remain
One down, one to go. A robust rescue package for Greece suddenly seemed a reality on Friday after Germany caved in to France and the European Central Bank by abandoning their demand to roll over Greek debt maturities. Details remain to be finalized on the Franco-Germany deal, but even as the Euro zone’s two biggest economies reached agreement, a major obstacle remains — whether the Greek government can survive a vote of confidence next week following this week’s cabinet reshuffle.

The collapse of the Greek government would cast doubt on the country’s ability to implement the deep market and budget reforms required by the E.U. and the International Monetary Fund in exchange for aid, threaten to derail any bailout and indeed potentially derail other euro zone economies.

On Friday, however, German and French officials insisted on focusing on the success of a compromise agreement. German Chancellor Angela Merkel, reeling from five consecutive losses in state polls, has in the past few weeks been reluctant to reach a deal with France given the populist anger in Germany over the massive taxpayer-financed bailouts for Greece, Ireland and Portugal over the past years. But with the global financial markets once again in turmoil over the last few days over fears that Europe’s sovereign debt crisis could threaten the entire Euro zone, Merkel decided it was time to do a deal.

The compromise agreement works essentially like this: instead of forcing investors to extend the maturities on Greek debt— as suggested by German Finance Minister Wolfgang Schuble — Merkel and Sarkozy now support a bailout plan for Greece that is based on the 2009 deal for Eastern European countries facing similar threats of default. Using the so-called “Vienna Initiative” as a template, Merkel and Sarkozy want European banks to maintain their exposure to Greece but to voluntarily roll over their bonds as they come due. This would buy Greece sufficient time to allow its fiscal austerity measures, economic reform and privatization of state holdings to kick in. In the meantime, an estimated 80 billion to 100 billion euros in fresh aid from the E.U. and the International Monetary Fund would provide sufficient funding until 2013 to keep the government running.